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In our recent note, “JACK HITS A SPEED BUMP”, we outlined our reasons for turning cautious on the stock given its outperformance versus the S&P 500 YTD. Qdoba’s disappointing performance was the key factor that moved us to change our stance following 2QFY13 earnings results. 

 

Qdoba Issues Not Transient

Having dedicated further time to Jack in the Box, since the May 15th earnings release, we have come to the conclusion that the issues facing Qdoba are most likely related to the location of its stores than a lack of brand acceptance among consumers. Tim Casey, the new president of Qdoba, was hired in March 2013 and has been given free rein to make the necessary changes to move the concept toward greater profitability and growth.

Over the next three-to-six months, we believe there is a high likelihood that Qdoba restructures its operations by closing stores and, perhaps, exiting certain markets completely. Currently, Qdoba has system stores in 44 states and others in Canada. Of those 44 states, 16 have 5 stores or less and generate lower-than-satisfactory returns due to the unit base being below the critical mass needed to raise brand awareness over the near-term. It’s difficult to say, at this stage, what number of Qdoba stores should comprise the system or which states or markets should be exited, but it is clear that significant changes are needed.

JACK Mgmt More Objective Than Most

Management teams tend to form a strong (almost unconditional) sense of allegiance to their own ideas but we believe that the executives in San Diego will attack the concept’s shortcomings with appropriate rigor.

Conclusion

From early 2012 until last week, we had described Qdoba as a call option for shareholders given the concept’s long-term growth potential. We still believe the upside potential in the stock, due to Qdoba’s growth potential, is perhaps 30% or more, but our confidence in shareholders realizing that return over the next three years has diminished. 

 

If or when the company moves to restructure Qdoba, we believe the impact on the stock could be a negative over the short-term but, ultimately, the decision will pave the way for the brand’s profitability to be improved, allowing investors to become more confident in assigning it a growth multiple. 

Howard Penney

Managing Director

Rory Green

Senior Analyst